Slow but Steady Economy Suits Mortgages

The latest update on growth in the American economy may have been too ho-hum to garner much attention, but for mortgages, this type of slow, steady growth may be just what the doctor ordered.

A Glass-Half-Full Economy

On July 29, the U.S. Bureau of Economic Analysis announced that real Gross Domestic Product grew at a 1.2 percent rate in the second quarter. Media and market reactions were tepid.

To understand why, think of this growth number as one of those glass-half-full or glass-half-empty situations. That 1.2 percent growth rate can be viewed both optimistically and pessimistically. Optimistically, this growth rate was higher than that of the prior two quarters, and marked the ninth consecutive quarter of positive GDP growth. Pessimistically, the second quarter only beat the prior two quarters because growth had almost ground to a halt over the previous six months, and 1.2 percent is still a pretty anemic rate of growth.

Just Right for Mortgages

Interest rates on 30-year mortgages ended the month of July exactly where they started it, at 3.48 percent. The announcement at the end of the July about the economy's mild growth in the second quarter fits right in with an environment that encourages low and stable loan rates.

The relationship between the economy and interest rates comes down to a question of balance – or to use an expression economists often borrow from a nursery tale, finding the Goldilocks scenario of a growth rate that is not too hot and not too cold.

Too much growth creates demand for capital, and that greater demand drives loan rates up. A hot economy can also create inflation pressures, which would also drive interest rates higher. So, it is very difficult to imagine mortgage rates staying around 3.5 percent during a booming economy.

On the other hand, an economic slump would not make for a good borrowing environment either. When the economy is bad, loan defaults rise. Lenders might react by raising interest rates to cover their heightened default risk, and they might tighten approval standards so much that only people with spotless credit histories could qualify for a loan.

This is where the balance comes in. The Goldilocks scenario for interest rates is one where the economy stays out of recession and keeps the job market strong enough that relatively few people are defaulting on their loans, but at the same time economic growth is mild enough that it does not create so much demand that prices and interest rates rise. A 1.2 percent growth rate, especially in the context of nine consecutive quarters of growth, qualifies as this Goldilocks scenario.

Slow but steady growth in the second quarter has helped mortgage rates remain low and relatively stable, but how long this can continue is uncertain. With an election coming up and the fallout from Brexit still to be felt, there are plenty of question marks on the economic horizon. Those contemplating buying a home, tapping into home equity, or refinancing a mortgage would do well to act before those questions start to have answers that interest rates don't like.